Budget manages to hold the line

Following up on the stalemate in the struggle of ideas, here’s my Fin piece from Monday

Some Budgets are drawn up under pressure, from political crises, economic shocks, or simply a mismatch between commitments and the resources to meet them. By these criteria, few governments have been less pressured than the Howard-Costello government in 2006. Itâ€™s a mid-term budget, so thereâ€™s no need to worry about electoral reaction. The Opposition is divided and adrift, the economy is riding a resources boom, and the government is flush with cash.

Given the freedom for manoeuvre created by these circumstances, the government had an unparalleled opportunity to set the direction of Australian policy on tax and public expenditure. The central question, inevitably, is whether the share of national income collected in tax revenue and returned as public expenditure is too low, or too high.

The governmentâ€™s answer, set out in detail in the Budget papers, is â€œJust rightâ€?. The revenue and expenditure shares of GDP are projected to hold rock steady at 23 per cent and 22 per cent respectively, leaving a 1 per cent surplus as a buffer. It seems as if the long dispute over the appropriate size of the state has been fought to a standstill.

Comparisons over the longer term are complicated by shifts in the role of Federal and state governments, and particularly the tiresome dispute over whether the GST is really a state tax. These disputes can be avoided if we look at the consolidated general government sector, which includes all levels of government. The Budget papers show that the public expenditure share of GDP has been just about constant for the past twenty years or so; ever since the famous Trilogy commitment made by Bob Hawke back in 1984, to fix or reduce expenditure, revenue and the deficit relative to GDP.

Hawkeâ€™s commitment ended nearly a century of steady expansion in the size of the state relative to the economy, and reflected a fundamental shift in public debate, away from the social democrats and socialists who had dominated it until the 1970s, and towards the advocates of resurgent free markets.

Many predicted and hoped that the expansion of the state would not only be halted but would be reversed. There were proposals to cut the public sector back to 25 per cent of GDP or even less. Such proposals are rarely heard nowadays. The idea of a minimal state seems as utopian as that of comprehensive socialisation of the means of production, distribution and exchange.

As John Howard observed before the 2004 election, â€˜There is a desire on the part of the community for an investment in infrastructure and human resources and I think there has been a shift in attitude in the community on this, even among the most ardent economic rationalists.â€™ The latest Budget had a reasonable amount of money for physical infrastructure but hardly anything for human capital (health, education and training); perhaps this is being saved up for the election year.

Looking ahead, the intergenerational analyses prepared by the Treasury suggest that the demands for public expenditure are only going to grow. This is partly because of the aging of the population, but more because of the inevitable (and desirable) growth of health care expenditure, as new and better treatments are discovered.

Although Treasury would like to hold down expenditure, the main concern implicit in the intergenerational framework is to avoid large increases in tax rates, which are seen as inconsistent with intergeneration equity. But, with growing demands, the only way to avoid future tax increases is to pay more now, and invest it in income-generating assets. This strategy is embodied in the Future Fund. Itâ€™s also reflected in the long-term shift from deficits to surpluses, which means that, while the public expenditure share of GDP has been almost unchanged, the tax revenue share has risen.

Itâ€™s possible that the stability we observe is an illusion, and that some economic shock or political eruption is just around the corner. For the moment, though, itâ€™s steady as she goes.

The Budget papers show that the public expenditure share of GDP has been just about constant for the past twenty years or so; ever since the famous Trilogy commitment made by Bob Hawke back in 1984, to fix or reduce expenditure, revenue and the deficit relative to GDP.

In other words the economic right have dented the armour of the left but have not won any sort of clear victory. We are stuck in the trenches and neither side will stand down.

In real terms essentials like food costs somebody much the same as what it did 20 years ago, however the cost of government has grown at the same rate as our incomes.

Given the fact that in absolute terms, or even in real per capita terms, the government is bigger than ever one could argue that the left has gained ground.

In response to Terje, can you really declare victory for left or right solely on the basis of the level of government expenditure? Surely you also need to look at the composition of that expenditure. For example, the federal government’s education budget is no doubt as large as it was in 1996, if not larger (I haven’t got time to check right now), but I’d guess that by far the biggest increase (certainly in percentage terms, if not absolutely) in federal educational spending has been on subsidising private schools. Hardly a victory for the left?

Think of it as an offset. To the extent that we save now for public servants’ superannuation, we won’t have to spend tomorrow’s taxes on a recurring basis as the liabilities become payable. Those taxes will be used on everything else.

The earmarking for super is window dressing. Costello had to come up with a reason to hide all that cash from the voters and the Nationals.

Actually, ab, I suspect the concealment of the Budget surpluses from the Nationals is just another layer of window-dressing.

A different avenue of concealment is that into which Prof. Quiggin appears to have strayed when he says in his post: “…with growing demands, the only way to avoid future tax increases is to pay more now, and invest it in income-generating assets.”

In fact, nobody is paying sufficient attention to the Future Fund. It is a huge innovation in public finance. Instead of investing in Australia, as Governments have traditionally done by way of providing infrastructure and services, the Future Fund allows the Government to invest in financial instruments of dubious relevance to the national interest or national welfare. Some of these Future Fund investments may even be in foreign companies in foreign lands. Taxpayers’ money is being used to prop up financial markets and funnel large sums into the pockets of professional fund managers. This is not what I pay taxes for.

Australian Governments concerned about long-term financial liabilities have a duty to invest in Australia so that the national wealth and national income in the future are equal to the demands to be made upon them. Future Fund investments, by contrast, are invitations to cronyism, inefficiency and ultimately default. The whole thing is a scandal which complacent Australians have ignored at their peril.

Couldn’t agree more Gordon. If the government is raising too much cash – stop raising it! Don’t just squirrel it away in some dubious fund that will create all sort of potential conflicts of interest – if you thought we had problems today with the government both owning and regulating Telstra – just wait until they own a significant share of a uranium mining company that David Murray’s team bought for the future fund!

JQ: Why is Telstra such a great investment? Telecoms are profoundly risky since disruptive technologies appear every few years. Telstra’s main asset is the copper network and that is looking increasingly vulnerable. Would you recommend that your mother buy only Telstra shares?

I currently pay nothing to Telstra – broadband (iBurst) is wireless and I have a mobile phone. This will only become more common as new technologies such as WiMax make copper less and less convenient.
Fibreoptics such as TransACT, broadband over powerlines and 3g are other major risks.
All this is great news for the consumer and Australian businesses – the last thing we need is the government running Telstra and passing regulations to shut down competition for their cash cow.

For example, the federal governmentâ€™s education budget is no doubt as large as it was in 1996, if not larger (I havenâ€™t got time to check right now), but Iâ€™d guess that by far the biggest increase (certainly in percentage terms, if not absolutely) in federal educational spending has been on subsidising private schools. Hardly a victory for the left?

If you look at the funding from all layers of government rather than just the one with traditional funding responsibility for private education I would expect that you would find little change in the relative funding of private and public students. Of course if you have data that says otherwise I am happy to look at it.

Some of these Future Fund investments may even be in foreign companies in foreign lands.

I bloody well hope so. It’s called diversification. If we’ve got money invested overseas that will reduce our exposure in the face of local shocks (eg if the Oz $ should ever go through the floor again).

Remember it’s the net, not gross, capital flows we’re worried about, assuming you’re of the school that thinks we should worry at all (but that’s another argument that’s been canvassed before on this blog).

Itâ€™s called diversification. If weâ€™ve got money invested overseas that will reduce our exposure in the face of local shocks (eg if the Oz $ should ever go through the floor again)

Depends where the money is going to really, doesn’t it? If the money is going to the US, then that won’t reduce our exposure to the almost certain devaluation of the US currency. That ain’t diversification, that’s just throwing money away.

The world’s major exporters are currently doing exactly that, of course. Doesn’t mean that we should necessarily follow suit. Just sayin.

the argument about whether the GST is a state or commonwealth tax may be tired and repetitive, but it is relevant in terms of the overall trends in revenues – because when the GST is counted as a Commonwealth tax, it confirms that this is the highest taxing federal government ever. Which is somewhat in contrast with popular perceptions of the Liberals as favouring smaller government – they are just as committed to big government as any of their predecessors. I suspect in light of the economic commentators pointing this out incessantly for many years, the popular perception may be turning around – but I have not seen any empirical evidence to that effect (does anyone know of any polling on the question?).

Although the rate of growth in the consolidated general government series may have slowed a bit over the last 20 years, the overall trend is still inexorably upwards.

When looking just at the Commonwealth, the time series is a bit skewed by some significant changes in responsibilities over the course of Federation – most importantly, the post WWII taxation agreement with the States that saw most taxing powers transferred to the Commonwealth.

Spending also grew post WWII due to post-war reconstruction, but then continued to grow unabated, to the extent that a major concern from the late 60s into the 70s was how to get the cost of government under control. The ‘trilogy’ was an important response but has now been replaced by the target of keeping the budget in balance over the course of the cycle – which in practice has not constrained an increase in the size of the state. This would not have been a bad thing if there had been significant investment spending – eg in education, communications infrastructure, ports and airports (instead most of the latter were sold).

The government has essentially two choices – find something useful and productive to do with our money or return it via cutting taxes. This is an important left-right divide in present debate, between those who think governments do have a useful role to play in society vs. those who don’t; but there’s probably a unity ticket in thinking that many (not all) of the current new spending priorities don’t meet the usefulness test.

JQ said:I share the concerns raised about the Future Fund. In terms of income-generating investment, renationalising Telstra would be a much better idea.

If you think $35 a month is steep for line rental, just wait and see what happens if Telstra gets renationalised.

I have no services from Telstra other than line rental. I get my broadband from other providers. Voice services over mobile. Long distance via VOIP and calling cards. Why? Because the other providers are far more competitive with far superior customer service. I probably pay at least three times what it costs Telstra to maintain the copper wires to my house and business. But I have no choice – they are the monopoly provider.

Renationalising a bloated, gouging, inefficient business is going to help the future of this country exactly how?

Stephen — you can’t just add GST to the commonwealth tax level to get a comparison, because the GST replaced a number of state taxes as well as the WST. To get a consistent time series you need to adjust commonwealth spending by (FAGS-BBA) which is the difference in the commonwealth-state subsidy. Doing this shows that the introduction of ANTS was roughly revenue neutral.

This is the highest taxing, highest spending government in Australia’s history. If you like small government — you should look back at Whitlam with nostalga.

Having said that — I agree with Q when he notes a change in the dynamics of politics in the 1980. I think he would agree that this happened around the anglosphere, and I think it marks the ultimate success of the social democrat model. The rate of growth of government has slowed.

We are now seeing a slow re-alignment of political alliances. The social democrat & socialist alliance is breaking down as the socialists (ie Greens) see that the social democrats have stopped the push for bigger government. The conservative & libertarian alliance is breaking down as the libertarians see the conservatives are conserving social democracy.

As an aside, it is obviously inappropriate to look at commonwealth government funding for private v public schools… as it is a well known fact that State govts are primarily responsible for public schools and the Cmwth govt took on the responsibility for funding private schools.

As another aside… if we’re all getting richer, doesn’t that decrease the argument for the need for government? Shouldn’t the size of government shrink in real terms as we get wealthier and people can more easily afford to fund their own health and education? To push the argument to the extremes, if we times everybodies real income by 10 tomorrow — surely we wouldn’t need more “help” (sic) from the government?

I would support re-nationalisation – but only so they could break the thing up and then re-sell it properly. It would destroy some shareholder value as Telstra as an integrated monopoly is worth more than as a series of competitive businesses, but would be good overall for the country. If they need to find a good use for some taxpayers dollars, this would be a good one.

I suspect that if you take the line rental monopoly out of Telstra, it is not worth much at all. (In fact, as I’ve noted here previously, the real monopoly is not over the lines themselves but over access to the conduits in which those wires run).

I agree that the monopoly piece should remain in public hands (only in the sense that it should be the public that decides (via our elected representatives) who is allowed to use the conduits and under what conditions – maintenance of the monopoly piece should be contracted out to private firms).

The rest of it could be sold off, but it is not worth much. Apart from Yellow Pages, most other pieces of Telstra perform poorly compared to their competitors.

The â€˜Future Fundâ€™ and privatisation is a popular topic. The other day someone came up with the following argument. The incomes of politicians and public servants and their advisers should be reduced with each privatisation in the form of selling public assets (rather than distributing shares to the public) because selling a shop means the managers of a shop are redundant. And, if the incomes of politicians and public servants and their advisers are reduced with privatisation then the retirement benefits decline too because they are a function of incomes. And, if the retirement benefit obligations decline as described, then the amount of amortisation required declines too. That is, less money is required for the future fund. And so the argument goes on and on until the conclusion is reached that the present estimate of the size of the future fund required to meet accumulated retirement benefit obligations is the best estimate of the amount of over-compensation that has gone to managers of public assets (politicians, public servants and their advisers) and as such it is an estimate of the amount of retirement benefits to be forfeited. I can think of legal arguments against this line of reasoning (honour obligations) but what are the economic or moral arguments against this line of argument?

Ernestine,
Perhaps you should look at the consequences of the converse – with each nationalisation their wages are increased etc. to see the stupidity of that position. How long before it is illegal to open a business without it being government owned?
If you say that any decision to reduce government power will reduce your wage it will provide a strong dis-incentive to taking any decision to do so – no matter how justified.
I take it you were typing in jest.

Overseas diversification of Govt. investment is an interesting concept, Derrida. I have some queries.

First, Australia is said to be a Big Country â€“ why does the Govt. need to diversify beyond that? If the purpose of diversification of investment is to provide income to be spent in Australia, overseas diversification must mean the Govt. sees higher and/or more secure returns on foreign investments than on investments which could be made at home and that currency risks are low. Though it is possible such an argument could be supported in the case of say, Mexico or the Ivory Coast, is there any good reason to think that this is true of Australia?

Second, money collected from Australian taxpayers and invested abroad is income from Australian sources which is not being invested in Australia. There is an opportunity cost to this which might be measured by the cost of the foreign borrowings needed to repair the resulting savings and investment deficiency. We already have a large continuing net income deficit which accounts for about two-thirds of our current account deficit (the other third is the trade deficit). Returns on Future Fund foreign investments might seem able to provide a counterweight to this net income deficit, but they should be reduced by the value of this opportunity cost. What would be left? How would it compare with the income from Australian investments which do not have to be so adjusted?

Third, Australian private investors who invest their savings abroad pay foreign taxes and get a credit in Australia for such tax paid. I presume the Future Fund investments would be treated the same way, so the Future Fund income repatriated to Australia would be net of foreign tax. If the Govt. invested the money in Australia (eg. by building some useful piece of infrastructure or even by buying shares) either no such tax would be payable or the Fund would be paying it to the Australian Govt. itself. Wouldnâ€™t that give a better result?

Andrew,
No, I didn’t type in jest, but you would be right in assuming that the argument does not represent my thoughts on the matter. The argument was presented to me and, in my opinion, its depth is no more shallow than that which underlies positions such as being categorically ‘pro’ or categorically ‘against’ privatisation as if there would be no criteria – other than ideological beliefs – for deciding when one form or the other is preferred. For example, your counter argument evaporates if the criteria of ‘super-additivity’ is introduced as a distinguishing condition for public ownership of services that are considered important or essential. ‘Super-addidivity’ is a concept from the ‘theory of the core’. It involves a form of positive ‘externalities’ in the sense of being defined as ‘the value of the whole’ is greater than the sum of the value of its parts. (I wonâ€™t make it precise because it would involve a language you advised me against using). In your earlier post, you say that the value of Telstra as a whole is greater than the sum of the value of its parts. I have no independent information to comment on the validity of your statement. But taking your statement as given, public ownership would be a reasonable conclusion on the grounds of telecommunications being essential for our lives and super-additivity applies.

Ernestine,
Purely because Telstra (as an entity) is worth more as a monopoly is neither here nor there. The distortional effects of a monopoly controlling what is (or should be) one of the most innovative parts of our economy are (IMHO) not worth the propping up of Telstra. Its continued blocking of new technology until its response is ready, fighting against access to its network etc. etc. etc. mean that the economy as a whole would (again IMHO) be better if there was no monopoly at all – either public or private. The creeping privatisation we got of it means we got an outcome that was (to put it mildly) less than optimal – the monopoly effectively in place, protected by government to preserve the share price and with a strong incentive to use its monopoly power for profit.
To me the government should re-nationalise it, break it up (destroying shareholder value, but improving the outcome for the vast majority of Australians who use it) and then sell off the bits, with a proper regulatory framework in place for the utility bits of the business until such time as the monopoly has gone. This would be an appropriate use of the surplus, and one that creates value for a long time to come.